DOL, SEC Fee Scrutiny Sparks Shift to Passive Investing

Use of passively managed funds and ETFs at indie BDs and wirehouses will accelerate, says Broadridge

As regulators zero in on ensuring investors aren’t being soaked in fees, independent broker-dealers and wirehouses are abandoning actively managed funds and embracing passively managed ones and ETFs, according to new research by Broadridge.

“During the first half of 2016, net new assets for passively managed mutual funds increased by $37 billion, or 14%, for the retail distribution channels, while actively managed funds were down by $24 billion, or 0.6%,” Frank Polefrone, senior vice president of Broadridge’s data and analytics business, said Thursday in releasing results from the firm’s most recent Fund Distribution Intelligence research.

During the first half of 2016, net new assets for passively managed funds and ETFs increased by 9% and 1% for IBDs and wirehouses, respectively, the research found.

Noting the Securities and Exchange Commission’s recently announced sweep of BDs’ and advisors’ share class picks, as well as heightened fiduciary rigor under the Department of Labor’s fiduciary rule, Broadridge expects “growing use of passively managed funds by advisors, along with the increasing popularity of ETFs to continue to accelerate.”

The New York Life employees’ lawsuit over the expenses of index funds in their 401(k) plan has broader implications for…

According to Broadridge, the bulk of the $35 billion of net outflows from actively managed mutual fund accounts held at IBDs moved to ETFs, which recorded an increase of net new assets of $34.9 billion.

The shift to passive ETF products by IBDs increased the overall share of passive products from 19.5% at the end of 2015 to 21% of total fund and ETF assets managed by IBDs, the research found.

Meanwhile, wirehouses experienced net outflows of $21 billion from actively managed funds, but only increased assets of passively managed funds and ETFs by $5.2 billion. “As a result, wirehouses experienced net outflows of long-term funds and ETFs of $13 billion in the first half of 2016, and lost overall market share to other retail channels.”

The shift from active management to passive products for other retail channels was not as pronounced during the first half of 2016, primarily because these channels already have a larger portion of fund and ETF assets invested in passive products.

For instance, the registered investment advisor channel, which Broadridge says has 33% of its assets in passively managed products, experienced “virtually no change in total mutual fund assets in the first half of 2016, while ETF net new assets increased by 2.4% during the same period.”

The discount channel – which the research reports has 55% of assets held in passively managed funds and ETFs and is dominated by Vanguard and Schwab discount brokerage operations — was up “significantly” in both net mutual fund and ETF assets.

Jon Henschen of BD recruiting firm Henschen & Associates notes that as Vanguard founder John Bogle likes to tout, “lowest price passive investing is in the client’s best interest” and is also embraced by regulators. “So active management, especially more expensive managers, are now swimming against the current,” and active managers “will continue to see outflow while low cost managers Vanguard, T.Rowe Price and ETFs will be benefactors.”

Henschen adds that while he’s “a fan of choices for clients … regulation restricts choices both in product choices and in how advisors are paid.” Regulators, he says, “rather than free markets, are choosing the winners and losers in our industry because they have the power to do so.”

Other key findings from the research showed:

Net new assets of ETFs for retail channels – RIA, IBD, wirehouse and discount BD – were up by $61.3 billion in the second quarter, while net new assets for institutional channels – private bank, bank and trust – were down by $30.4 billion.

Net new assets for retail long-term funds were up by $12.8 billion, while institutional long-term fund net flows increased by $71.7 billion.

Net new assets of passive products for the retail channels increased across major U.S. product categories – U.S. large cap (+13%), U.S. mid-cap (+11.6%), and U.S. fixed income (+20%).

Net new assets of active products for the retail channels decreased for U.S. large cap (-2.7%), U.S. mid cap (-6.7%), U.S. small cap (-0.4%) and increased for U.S. fixed income (+5.7%), high-yield income (+4.8%) and U..S. municipal (+11.7%).